Ethanol is only part of story behind high corn prices

WEST LAFAYETTE, Ind. — Those who blame ethanol for high corn prices need to dig deeper — oil well deep, said a Purdue University agricultural economist.

“If you say biofuel production is the reason corn prices are going up, you would be right,” said Wally Tyner, an energy policy specialist. “But the more important question is why biofuel production is up. Many have blamed the federal subsidy on ethanol, but today that is a small part of the overall picture.”

As the per-barrel cost of crude climbs, corn prices are pulled higher by increased ethanol production, Tyner said. Ethanol production is growing through the combination of consumer demand and federal energy policy.

“Essentially, the mechanism is that higher crude prices lead to higher gasoline prices, which leads to higher ethanol demand, which leads to more ethanol production, which increases corn prices,” Tyner said.

Analysis

Tyner’s analysis of the federal Renewable Fuels Standard that mandates ethanol production and the government subsidy for ethanol indicates that corn price trends have followed crude oil markets.

“Most of the corn price increase is due to the higher oil price, not the ethanol subsidy,” Tyner said.

Ethanol is subsidized at 51 cents per gallon. Ethanol subsidies have been in place in the United States since 1978. Fuel ethanol production began in the early 1980s, and for the 20 years that followed, oil prices ranged from $10 to $30 per barrel, except for a couple of brief exceptions, according to Tyner.

The crude oil price averaged $20 a barrel from 1983 to 2002. During that same period, the ethanol subsidy was 40-60 cents per gallon, averaging 50 cents per gallon. Because crude oil prices were low by comparison, there was no economic incentive to push rapid ethanol production.

With corn priced around $2.25 a bushel at that time, per-barrel crude oil prices would have had to approach $60 for ethanol to be profitable without a government subsidy, Tyner said.

“The subsidy was essential for launching the U.S. ethanol industry,” he said. “It was a combination of the fixed subsidy and — by today’s standards — cheap oil that brought the ethanol industry into being.”

Crude prices

The recent run-up of crude prices to $120 a barrel and more has had a profound impact on corn prices, Tyner said.

“Moving from $40 a barrel oil to $120 oil with no ethanol subsidy or Renewable Fuels Standard mandate in effect still leads to a tripling of corn prices,” he said.

With no subsidy or mandate, corn moves from $1.71 a bushel at $40 oil to $5.26 a bushel at $120 oil. With the subsidy or mandate, corn moves from $2.26 a bushel at $40 oil to $6.33 a bushel at $120 oil.

Put in round numbers, when crude went from $40 to $120 a barrel, corn went from $2 a bushel to $6 a bushel, a tripling of both prices. About $1 of the corn price increase was due to the subsidy and $3 to the higher crude price.

Even if the government subsidy for ethanol were eliminated, corn prices would not return to levels of a decade ago, Tyner said. The Renewable Fuels Standard mandates that by 2015 at least 15 billion gallons of ethanol be produced annually from corn.

Since the federal law was adopted in 2007, ethanol production has exceeded the mandated annual level. Because of the fuel standard and ethanol subsidy, corn prices would not drop below $3 per bushel even if crude oil prices fell back to $40 a barrel, Tyner said.

“At present, federal policies do induce a higher corn price,” Tyner said. “But at high oil prices, the role of oil price is more important than policy in driving corn price.”

Tariffs

Tariffs on imported ethanol could force corn prices lower, especially if the tariffs lead to alternative sources of ethanol, Tyner said.

“Since high oil prices directly lead to higher corn prices, corn ethanol becomes much more expensive,” he said.

Sugarcane-based ethanol is cheaper to produce than corn ethanol at any oil price, but the gap widens at higher oil prices. The removal of the tariff on imported ethanol would lead to the biofuel coming from the lowest cost source — sugarcane — which would reduce some pressure on corn prices and provide the U.S. with lower cost ethanol, according to Tyner.